The Community Reinvestment Act and the Mortgage Loan Crisis
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UPDATED: May 23, 2012
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The mortgage loan crisis of 2008 gave rise to the largest recession our nation has seen since the Great Depression. This time of economic failure was so bad, in fact, that the period became unofficially known as the Great Recession.
Immediately party lines were divided. Democrats pointed fingers at the Bush administration and Wall Street, while Conservatives pointed fingers at the government and borrowers themselves.
But there’s more to this tale than those who were around at the time of the plummet. We have to go back decades and work our way back to the present in order to discover the true root of the mortgage loan crisis.
Before we dive directly into the mortgage loan industry and attempt to make sense of what went wrong, we need to have a firm understanding of American culture and how that transferred itself into the financial realm.
It was on January 31, 1865 that the U.S. House of Representatives passed one of the most important Amendments to our Constitution: the 13th Amendment. This addition to the Constitution not only escorted change into the United States, but it also acted as a symbolic herald of freedom that the entire world saw. The most powerful nation on Earth declared that all men, regardless of color, were free and equal. The concept of freedom won a massive victory on January 31 of 1865.
But, as we know all too well, laws are not always upheld.
American culture, particularly at that time, retained its heavily racist attitude. Whites continued to subjugate Blacks, and despite what our Constitution said, Blacks did not experience the same sort of freedom that their lighter-skinned counterparts did.
It wasn’t until nearly 100 years later, with the Civil Rights Movement of the 1950s and 1960s, that we began seeing true equality emerging.
Yet even after Brown v. the Board of Education, Rosa Parks and the bus boycotts, the restaurant sit-ins, the freedom rides, The Civil Rights Act of 1964, and Dr. Martin Luther King’s legacy, some of the population continued to preserve the notion that certain members of society were better than others.
This mentality, whether consciously or unconsciously, saw its way into the mortgage loan industry.
The Practice of Redlining
Throughout the mid 20th century, banks were rather blatantly denying various groups from financing mortgage loans based purely on the color of applicants’ skin and on their perceived financial background.
Banks would trace the boundaries of predominantly black neighborhoods on maps with red lines so that they could quickly delineate where populations existed that they should not lend to. Thus, this practice became known as “redlining.”
Redlining effectively locked Black families into neighborhoods and gave them little to no chance of ever migrating out. Many argue that it is due to this practice that those neighborhoods diminished in value and gave rise to the impoverished inner-cities that we know today.
Naturally, this discriminatory practice flew right in the face of the 13th Amendment and the Civil Rights Movement.
The Community Reinvestment Act of 1977
It was in 1977 that the Community Reinvestment Act was signed into law by President Jimmy Carter, and it was this action that many analysts deem the start of the mortgage loan bubble.
The Community Reinvestment Act was a direct response to redlining and the practice of denying mortgage loans to Blacks and other minorities.
From the law itself, the wording from Title VII, Sec. 802 (a) is as follows:
The Congress finds that regulated financial institutions are required by law to demonstrate that their deposit facilities serve the convenience and needs of the communities in which they are chartered to do business. The convenience and needs of communities include the need for credit services as well as deposit services; and regulated financial institutions have continuing and affirmative obligation to help meet the credit needs of the local communities in which they are chartered
In other words, banks and lenders located in a certain area would be required to issue mortgage loans to a certain amount of applicants in that area.
The Community Reinvestment Act of 1977 was not a bad move from a civil standpoint. Nobody should be discriminated against in any realm of life based on their ethnicity, color, gender, or religion. “Redlining” was in direct opposition to the heart and philosophy of the United States of America.
But the fact that the law essentially said that banks and lenders had an “obligation” to meet the credit needs of their corresponding areas opened up a Pandora’s Box of financially irresponsible practices.
As we soon learned, economic affirmative action does not work, and as the Community Reinvestment Act continued to encourage subprime mortgage loan lending, we saw our market grow more and more volatile.
Fair but Not Responsible
The Community Reinvestment Act was a self-enforcing law. With the passing of this bill, a CRA regulatory agency was created. They would assign Banks and lenders a CRA rating based on how many applicants in their local communities were approved for mortgage loans. A higher CRA rating did little for mortgage loan lenders, but a lower CRA rating was detrimental.
According to the National Community Reinvestment Coalition (NCRC), “If a regulatory agency finds that a lending institution is not serving these neighborhoods, it can delay or deny that institution’s request to merge with another lender or to open a brand or expand any of its other services.” In other words, if a bank doesn’t comply with the Community Reinvestment Act’s demands, it will be destined to live a stagnant business life, which correlates to financial suicide in a capitalistic economy.
While the Community Reinvestment Act had noble intentions, and while it fostered fair lending practices, it did not promote responsible lending practices. In fact it did just the opposite.
The Bubble Began to Inflate
And so we entered the age of the subprime, and lenders began wavering on their responsible practices in order to provide mortgage loans for financially unprepared borrowers, simply so they could meet the Community Reinvestment Act’s demands in order to keep up with their competitors’ ability to expand and grow.
Then the government dove headfirst into the mortgage securitization business, encouraging Fannie Mae and Freddie Mac—collectively known as government security entities (GSEs)—to purchase mortgages from lending institutions. As these GSEs continued to gobble up subprime mortgage loans, concern over their stability—or lack thereof—grew.
“We need a strong world-class regulatory agency to oversee the prudential regulations of the GSEs and the safety and soundness of their operations,” warned John Snow, Treasury Secretary for the Bush Administration, in 2003.
Alan Greenspan, the chairman of the Federal Reserve during that time, sided with Snow, as he issued a warning at a Federal Reserve Committee Hearing in February of 2005. “[By] enabling these institutions to increase in size… we are placing the total financial system of the future at a substantial risk.”
But then there were those who disagreed.
Barney Frank, a Democrat from Massachusetts, long supported the GSEs and their acquisition of mortgage loans. Frank became famous for vocalizing his lack of concern over the GSEs perceived problems in spite of everybody else’s growing panic.
“Fannie Mae and Freddie Mac are not in a crisis,” he said at a hearing in September of 2003.
And so the GSEs continued to swell in size, acquiring ownership of more than 70 percent of all newly originated mortgage loans. Onlookers sat helplessly on the sidelines as these two massive entities began shaking with pent up pressure. The Office of Management and Budget revealed that the GSEs had major accounting problems, and that they couldn’t keep up with the massive amounts of delinquencies and foreclosures that were occurring in the mid-2000s.
While the mortgage loan bubble was growing before the nation’s eyes, some, such as Frank, insisted on keeping their eyes closed.
“Those who argue that housing prices are now at a point of a bubble seem to me to be missing a very important point,” said Frank on the House Floor in June of 2005 two years after his denunciation of the GSEs being in a crisis. “Unlike previous examples we have had, where substantial excessive inflation of prices later caused problems, we are talking here about an entity: home ownership… Homes that are occupied may see an ebb and flow in the price at a certain percentage level, but you’re not going to see the collapse that you see when people talk about a bubble.”
Frank, a huge proponent of the Community Reinvestment Act, a vocal supporter of subprime mortgage loans, and a vehement advocate of keeping the GSEs unregulated, lead the charge into the realm of irresponsible financing.
And so Frank, who famously said, “I want to roll the dice a little bit more in this situation towards subsidized housing,” got to see his gamble play out.
What was kick started by the government’s demand for lenders to issue subprime mortgage loans to the financially unprepared, turned into the largest economic catastrophe our nation has seen since the 1930s. And when the “non-existent” bubble ruptured in 2008, it was the entire nation who got to pay for such a gamble as their home values, their jobs, and their retirements fell into ruins.